CalSTRS' investment committee in January is expected to consider adding the use of leverage to its toolkit to help staff manage liquidity and reduce risk.
Staff plans to present a revised investment policy statement to the board in January that would allow the use of leverage across its portfolio but would also increase how far the portfolio can stray from long-term asset allocation targets, expanding the permissible asset allocation ranges by a proposed 2%.
The $307.9 billion pension fund's investment team wants to be able to use leverage across its entire portfolio in times of market distress by borrowing when there is low or negative cash flow, repaying the debt when flows normalize as well as employing derivatives to rebalance the portfolio. In both scenarios, CalSTRS would reduce leverage when the markets and cash flows normalize.
The California State Teachers' Retirement System, West Sacramento, currently has leverage policies related to certain asset classes: real estate, inflation sensitive and securities lending, and uses derivatives such as futures in fixed income and global equity.
Using leverage to reduce risk seems counter intuitive, Geraldine Jimenez, senior investment director of public markets told the investment committee at its Nov. 1 meeting. But she noted that it would have been helpful during times of market dislocation such as in 2008 when the fund lost 26% of its value and couldn't rebalance, resulting in CalSTRS reducing its commitments to private markets, she said.
According to a separate report, public equity risk and private equity risk combined comprised about 79% of CalSTRS total portfolio risk, with public equity accounting for 51% of portfolio risk as of Aug. 31. Public equity is CalSTRS' largest asset class, with 39.3% invested in the asset class as of Aug. 31. Private equity and real estate were the next largest sectors, with 15.8% invested in each asset class.
As CalSTRS has been increasing its exposure to private markets, most recently by boosting its private debt allocation, it would be helpful for staff to be able to use some leverage during market downturns to get to market exposure and to continue committing capital to private assets, Jimenez said.
In May, CalSTRS reduced its public equity holdings by 4 percentage points to 38%, and increased fixed income by 2 percentage points to 14% to fund CalSTRS' private credit direct-lending strategy. CalSTRS had added a 5% private credit allocation to its fixed-income portfolio in 2021.
